Will 2013 bring a genuine, no-holds-barred recovery?
By Neil Irwin,
The Great Recession, which began exactly five years ago, is fast receding into the history books. But its effects don’t merely linger; they haunt almost every region, industry and household. With each turn of the calendar, the world wonders and hopes: Will this be the year?
Will this be the year that the economy breaks out of its pattern of sluggish growth that has held since the recession ended in 2009?
Will this be the year that jobs are created on a large scale, that people who haven’t seen a raise in half a decade might finally see bigger paychecks?
Will this be the year banks lend and businesses expand and some of the millions of idle workers finally see the opportunity to ply their trade?
As we face another turn of the calendar, the answers for 2013 are suddenly different. The good news is that the forces that have been holding back the economy at last are abating. Housing is now adding to growth in a big way (and poised to do so even more), consumer debt burdens are way down, and state and local governments seem to have largely finished their steep retrenchment. Even the euro-zone crisis has entered a less scary phase, with the continent facing a nasty recession but no longer a catastrophe that could upend the global financial system.
The bad news is that new threats are emerging to take their place. The most immediate are home-grown: the risk of a sudden onset of federal austerity born of a dysfunctional political system. As Goldman Sachs economists titled a report, judging what growth will look like in 2013 is a question of “Economics vs. Politics.”
There are murkier risks lurking abroad, from conflict in the Middle East, a recurrence of Europe’s woes or a downturn in the powerhouse Chinese economy. So what kind of year will it be? It depends on which forces prove most powerful.
By all rights, 2013 should be a year of rip-roaring recovery. The simple reason is this: The old headwinds are running out of steam. The question is whether new headwinds will take their place.
Housing: The biggest cramp in the economy these past few years has been the housing sector, with sales near historic lows for half a decade. At first, this was a necessary adjustment, as the overbuilding of homes during the 2000-06 boom was worked off. But we’re far beyond that point, with significant under-building of homes relative to demographic trends. That’s true even when one adjusts for the lower-than-normal “household formation” during the recession and its aftermath (think young college graduates living in their parents’ basements).
Now it seems this mismatch — too few houses being built relative to the number of people who need a place to live — will be resolved. The number of housing units started, an 861,000 annual rate in November, was up 22 percent from a year ago and up a whopping 58 percent from two years ago. And there is plenty of reason to think that the upswing will continue. That number is still well below many estimates of the longer-term rate of household formation, which put it in the 1.2 million ballpark. That means there is plenty more room for housing construction to grow, and to boost the economy.
One more positive: So far, the increase in construction jobs has not matched the increase in home-building activity. In fact, for the year that ended in November, the number of residential construction jobs fell by 5,000. It is a bit of a mystery as to why, but one sure thing is that it can’t go on forever; if building activity keeps rising, construction companies will need more workers. And this is low-hanging fruit for helping the labor market; the jobless rate among construction and extraction workers was a high 12.9 percent in November. Taking construction workers who are sitting idle and putting them to work building houses and apartment buildings for a growing population is just what this economy needs.
Household debt. American consumers, we have often heard, have been weighed down with debt incurred during the boom years — credit card bills, student loans and, especially, burdensome home mortgages. A widespread theory is that consumer spending won’t rebound until Americans have dug themselves out from under those debts.
Through a combination of their own efforts to save money, low-interest rate policies from the Federal Reserve and defaults and foreclosures, Americans seem to be far along their deleveraging path. The ratio of household debt-to-GDP has fallen from a peak of 98 percent at the start of 2009 to 81 percent in the third quarter, about the 2003 level.
The cost of servicing that debt is down even more because of low interest rates; the ratio of household debt servicing costs to after-tax personal income was down to 10.6 percent in the third quarter, near its lowest levels on record. The Fed’s policy actions have brought down rates on credit cards and auto loans, and more people are able to refinance their mortgages as home prices rise.
Household balance sheets are looking as good as they have in a decade, which means that as 2013 begins, debt overhang no longer looms over the economy.
State and local governments. The budget woes of states and municipalities have been persistent drags on the economy. State and local governments have slashed spending and jobs, essentially counteracting federal stimulus with their own fiscal anti-stimulus measures.
From 2000 to 2008, state and local governments added an average of 226,000 jobs a year. But since 2008, the sector has cut an average of 154,000 a year, as states struggled to balance shrinking budgets hampered by lower tax revenue and higher spending on social welfare.
But they may finally be through with that adjustment process. With tax revenue climbing and major budget-cutting completed, state and local government employment seemed to have bottomed out in May and has been on a gentle upswing since (adding 48,000 jobs in the ensuing six months). Don’t look for this sector to be a major driver of hiring, but by ceasing to be a negative, it could stoke the recovery in 2013.
How Washington could ruin it
The biggest dark cloud hanging over the horizon is right in the middle of the District of Columbia. Look for the building with the giant dome.
It is not simply that the federal government could mess up what should, by all rights, be a good year. It is that there are so many ways that government policy could mess things up. The open question is which will prevail: the improving economic fundamentals or the rapidly deteriorating political fundamentals.
The three major ways Washington could bungle the recovery:
Going off the cliff. This is the most scrutinized possibility, the one that has been widely analyzed (and, as of Thursday morning, at least, seemed like a growing possibility). It took a long series of events to arrive at the “fiscal cliff” of Dec. 31: the initial decision by the George W. Bush administration to agree to a finite end date for its tax cuts; an agreement by the Obama administration at the end of 2010 to extend those tax cuts and other measures for two years; and a deal to raise the debt ceiling in August 2011 that put in place large and unpopular automatic spending cuts if no deficit reduction deal is reached. Now that all those deadlines have converged, to New Year’s Day 2013, the question is whether the key factions can come to a deal to avert an austerity crisis — too much deficit reduction, too soon.
If there is no deal, and we pitch off the fiscal cliff with no resolution in sight, it means higher taxes on almost all Americans and dramatic cuts to both defense and other government programs. There would almost certainly be a recession.
If the nation goes off the cliff, and stays there, the Congressional Budget Office estimates it would amount to a drag on gross domestic product of 2.9 percentage points in 2013, and would increase the jobless rate by 3.4 percentage points over its current 7.7 percent.
Of course, a deal could have its own perils.
Too much austerity, too fast. There are already hints that may happen: In negotiations that broke off last week, President Obama had reportedly conceded that a two percentage point payroll tax holiday, put in place as a stimulus measure at the end of 2010, would be allowed to expire. That expiration would decrease the average working class American’s after-tax pay by about $1,000 over 2013 — less money in their pockets, and less aggregate demand in the economy. The CBO estimates that the end of the payroll tax holiday, combined with an extension of unemployment benefits, could cost the economy 0.7 percentage points of growth and increase the jobless rate by 0.8 percentage points over what it otherwise would have been.
That probably doesn’t mean a new recession, but is enough to turn what should be a better year into another year of muddling along.
Obama has pushed for other stimulus measures to counteract that drag, perhaps along the lines of new infrastructure spending. Congressional Republicans are opposed. How things shake out — and how rapid the onset of austerity is — will go a long way to shaping 2013.
Debt ceiling hijinks. In late February or early March comes a deadline with even more at stake: The legally mandated cap on how much debt the Treasury can issue will become a binding constraint, setting the stage for the same messy negotiations that walloped financial markets and business confidence in summer 2011.
What makes debt ceiling negotiations so perilous is the threat that congressional Republicans make, in effect, to allow the government to default on its debts should they not get their way on major spending cuts.
Whereas going over the fiscal cliff means only a recession, a failure to raise the debt ceiling would mean a freeze-up of the global financial system and a serious blow to the credibility of the U.S. government as a safe place to park money. The 2011 standoff, even after resolved, led Standard & Poor’s to downgrade the government’s credit rating, citing the “political brinkmanship.”
Obama proposed eliminating the current procedure, in which Congress must affirmatively vote to raise the debt ceiling, in favor of one where Congress must instead vote to override the president’s decision to raise it. Republicans rejected that, seeing the debt ceiling as a key lever of power they have to influence the course of government spending despite controlling only one house of Congress.
This much is clear: A standoff won’t be good for business confidence, consumer confidence or financial markets.
Add up these three things, and the mission for leaders in Congress and the Obama White House is clear: Resolve the fiscal cliff, but in a way that phases in austerity gradually. And don’t play games with the debt ceiling. If they can navigate that tunnel, they will allow room for the private sector to have a good year. Unless, of course, there are other, harder to anticipate headwinds from across the seas.
Beyond America’s borders, there remains peril in all directions — though of a variety that is hard to measure and predict. Let’s look at some of the spots that could combine with domestic politics to undermine the nation’s solid growth prospects. In 2008, the U.S. financial crisis sparked a global recession; another country could do the same to us.
Europe: It is the economy that is forgotten, but not gone. Financial markets have been surprisingly bullish on the euro zone since late summer, when the European Central Bank announced a potentially bottomless backstop to prevent the dissolution of the 17-nation euro currency area.
That has led to a surprising sense of calm on global markets. Even when there are political or economic tremors — such as new worries over Catalonian separatism in Spain or the return to the political scene of bombastic former Italian prime minister Silvio Berlusconi, it no longer results in huge selloffs of Spanish and Italian bonds and stocks. Even Greek bonds are on a bit of a bull run in past months, as investors start to think that nation has seen the worst of it and will stay in the euro zone.
The question for the U.S. economy is whether the Pax Europa can hold. Will the ECB’s firewall and the European governments’ commitment to collectively backstop one another’s banks and government treasuries be enough even in the face of recession in much of the continent (and quite severe in Greece, Spain and Portugal)? Germany holds elections in the fall; might there be a populist outcry to the sense that Chancellor Angela Merkel and her government are bailing out a bunch of profligate Greeks and Spaniards?
Markets are increasingly betting that the euro zone crisis is solved. Let’s hope they are right.
Europe isn’t the only trouble spot on the world map. Egypt is in turmoil, Syria is in flames and the Middle East a seemingly perpetual tinderbox. If the unrest were to spread to some of the major oil-producing nations on the Arabian peninsula, or armed conflict to break out between Iran and Israel, it would almost surely drive up the price of oil. Any of it would hurt an economy trying to pull out of its rut.
China: The world’s growth juggernaut decelerated this year, with growth in 2012 somewhere in the ballpark of 6 percent as opposed to the 10 to 12 percent that had become its new normal.
For almost any other nation on earth, that would be a gangbuster growth rate, but the slowdown sparked worries among the pundit class that even a modest slowdown would expose structural weaknesses in China’s economy: years of high investment and relatively low consumer spending; the political favoritism driving those investment projects; and the discontent bubbling beneath the surface of an emerging middle class that lacks democratic means to vent those frustrations.
None of that has brought China to the brink of crisis. Rather, it seems to be experiencing a routine economic slump without anything worse bubbling to the surface. That is good news. As a new government takes office and finds its footing, the best hope is that China can work through its longer-term problems with only a modest hit to short-term growth.
The same could be said of other emerging markets, like Brazil, India and Indonesia. Each saw a slowdown in the second half of the year, sparked in no small part by weakness in their export market of Europe. As long as those nations maintain progress without any big hiccups, they will support broader growth.
Japan: The world’s third-largest economy elected a new government last week that is pledging to undertake an aggressive Keynesian prescription for the nation’s long-standing economic ills, including new spending and pressure on the central bank to push more money into the economy and try to provoke more inflation. It will be a great test of the policy prescriptions offered by the likes of many on the left for the Western world.
If it works, Japan will finally reverse two decades of economic stagnation and low-level deflation and emerge as a growth juggernaut. If it fails, then Japan’s largest-in-the-world debt relative to GDP will come crashing down. The first outcome would be generally good for the United States (though bad for American exporters that compete with Japanese firms). The second could be a catastrophe.
! It’s looking up. For real: Consumer debt is mostly cleared up, the housing market is doing better and the financial system is on the mend.